This blog, written by Thomas E. Rutledge, focuses primarily on business entity law in Kentucky. Postings on contract law, contractual and statutory construction, and the entity law of other jurisdictions appear as well. There may as well be some random discussions of classical, medieval and renaissance history.

Wednesday, July 6, 2016

Distributions to Working Interest Holder in Oil & Gas Venture Held Subject to Self-Employment Tax

Distributions
to Working Interest Holder in Oil & Gas Venture Held

Subject to Self-Employment
Tax

Recently, the 10th
Circuit Court of Appeals affirmed a determination that the holder of working interests in an oil and gas ventures
was a partner in a partnership and in consequence the distributions from the
venture were subject to self-employment tax.Methvin v. Commissioner, No.
15-9005, ___ Fed. App’x ___, 2016 WL 3457623 (10th Cir. June 24,
2016).

Methvin owned various 2-3% working
interests in certain oil and gas ventures.In 2011, he received certain distributions on which he paid income tax,
but no self-employment tax.The IRS
sought $690 in self-employment tax.Methvin objected to that levy, asserting (it would appeal from the
decision) that he was not a partner and the distributions were not subject to
self-employment tax.He lost on that
argument when presented to the Tax Court (referred to in this decision once as
the “district court”), and he lost again before the 10th Circuit
Court of Appeals. The Tax Court’s decision is Methvin v. Commissioner, No. 28477–13, T.C. Memo. 2015-81 (April
27, 2015).

Initially, the 10th
Circuit affirmed the determination that, based upon the facts here at issue,
there existed a partnership between Methvin and the operator of the wells.While he argued he was only a passive
investor, he had extensive rights under the agreements particular to these
ventures including the rights to:

• obtain any information reasonably requested
regarding development and operation; and

• inspect the operator’s records.

Further,
Methvin shared certain obligations as to expenses.On these facts the determination that a
partnership existed was affirmed.There
being a partnership, self-employment taxes were due and owing on the
distributions made.

It needs to be emphasized that the
determination that a partnership existed was made on the facts and
circumstances of this particular arrangement.Methvin argued that the specifics of this arrangement were sufficiently different
from those of Cokes v. Commissioner,
91 T.C. 222 (1988), wherein a partnership was also found, that no such
determination should here be made.That
effort of distinguishing was not successful.Rather:

These differences might have led the Tax Court to arrive at
a different factual finding here, for “each case must rest on its own facts.” Jones v. Baker, 189 F.2d 842, 844 (10th
Cir. 1951). But the Tax Court did not clearly err by characterizing Mr.
Methvin’s arrangement with the operator as a partnership. In the absence of
clear error, we uphold the Tax Court’s finding that the arrangement constituted
a partnership.(footnote omitted).

Persons holding oil and gas
interests need to carefully consider whether they are in partnerships and are
therefore subject to self-employment taxes on their distributions.This is a particularly involved question of
law for which attention to the details of each particular arrangement are
necessary.